Why today’s debt crisis requires a different kind of thinking

By David McNair, Executive Director for Global Policy at The ONE Campaign and Non-Resident Scholar at the Carnegie Endowment for International Peace and Daouda Sembene, CGD Distinguished Nonresident Fellow and AfriCatalyst CEO

African countries have more than doubled their debt stocks in the last decade. In an era of historically low interest rates that made sense, given the continent’s massive infrastructure needs, high security spending and rising social expenditure driven by a rapidly growing population. But that era is now over. 

Twenty-two African countries are now either bankrupt or at high risk of debt distress. Median debt service costs tripled from 3.4% of government spending in 2012 to 10.3% in 2022. As the US Federal Reserve increases interest rates, the cost of servicing debt (much of which is in US dollars) is increasing and the strength of the US dollar is diminishing African countries’ spending power. This is equally true of many countries in the Global South.

Yet the failure of G20 leaders to deal with the systemic risk created by this debt vulnerability is myopic for three reasons:

First, stability

Many countries in the Global South are facing a hunger and poverty crisis driven by conflict, and higher energy and food import costs. In 2021, there were 193 million people in urgent need of food assistance. In 2010-11, a food price crisis precipitated unrest in 40 countries and sparked what became known as the Arab Spring. Debt service costs are reducing the fiscal space for countries to respond, and defaults could make the situation worse. This is all the more acute in the most climate-vulnerable countries, which, in the next four years, owe almost USD 500 billion in debt service. To respond to natural disasters, which are increasing in frequency and severity, they take on loans to repair the damage, which increases their debt stocks. Many of these countries cannot afford to build climate-resilient economies or stop producing and using fossil fuels without defaulting on their debt.

Second, geopolitics

Europeans were surprised when many Southern countries abstained from a succession of UN General Assembly votes condemning Russia’s actions in Ukraine. While there are a number of factors behind these decisions, it is clear that Russia is pursuing a proactive strategy to increase its influence in the region. The leaders and citizens of countries in the Global South are now increasingly frustrated that Western governments are failing to step up with adequate support. Countries under pressure are keeping their options open and some are turning to Russia for weapons and to China for more borrowing.

Third, economics: Without early resolutions to debt sustainability issues, the taxpayers of G20, and particularly G7 countries, could end up footing the bill for a much larger problem. During the 1980s and 1990s when Southern countries were facing similar debt sustainability challenges, multilateral institutions lent more money, which enabled the debt to keep being paid, and effectively bailed out previous lenders. In the early 1980s, 48% of these countries’ external debt payments were to private lenders and by the late 1990s this had declined to 10%. The debt had effectively been transferred to multilateral institutions, which held 59% of the debt stocks. When debt cancellation was finally agreed through the Heavily Indebted Poor Countries (HIPC) and Multilateral Debt Relief initiatives (MDRI) in the 2000s, public lenders paid the costs.

G20 debt initiatives are not working

During the COVID-19 pandemic, G20 countries put in place a Debt Service Suspension Initiative (DSSI), which offered limited breathing space for select countries struggling with the aftershocks of the pandemic. It expired in December 2021. The G20 Common Framework for Debt Treatments launched in 2020 aimed to deal with underlying debt vulnerabilities. Almost two years after it was established, only three countries (Chad, Ethiopia and Zambia) have applied.

It appears that G20 leaders remain happy with stalemate, focusing on blaming others rather than taking responsibility for implementing obvious solutions. Meanwhile, private creditors do nothing. The IMF and World Bank highlight the severity of the problem and propose solutions but say they cannot implement them. No one moves.

Recent breakthroughs for Chad and Zambia have offered too little too late. It is therefore understandable that countries struggling with their debt sustainability have little incentive to embark on this cumbersome and unrewarding process. Meanwhile, middle-income countries such as Sri Lanka facing major debt challenges are not even eligible.

To address the multiple ongoing crises related to energy, food, security and the environment, governments will require the international community to act differently. This could be as simple as doing for vulnerable African countries what is routinely done for other countries with similar needs.

  1. Fix the common framework or call it quits: In 2021,the IMF proposed four changes to the Common Framework, which should be implemented immediately. These include suspension of service upon application, clarity on how the various creditor groups will be treated comparably throughout the process, and the expansion of eligibility to other highly indebted countries.

  2. Rework debt contracts so they work for the 21st Century: Given the increased risks associated with pandemic and climate related shocks, forward looking debt contracts should build in clauses that allow space for responding to these shocks. Barbados has led the way. When triggered, its debt contracts include disaster clauses which, can free up USD 700m or 15% of GDP to use on disaster response. This should build on new lending rules drawn up by the IMF and the World Bank, which allow indebted countries to pause debt payments. This would require independent pricing, verifying the scale of the shock and full transparency of debt contracts.

  3. Expand guarantees to mitigate the risks associated with doing business in poor countries. In November 2022, the European Commission made public a proposal for a EUR 18 billion package of highly concessional loans for Ukraine to help cover a large part of its short-term funding needs for 2023. These funds are expected to be raised from the market, with the headroom of the 2021-2027 EU budget being used as guarantee. Similar innovative schemes are not typically developed to enhance developing countries’ access to cheaper debt on better terms. They should be.
  4. Leverage the IMF’s Resilience and Sustainability Trust: A newly established trust at the IMF could facilitate access to financing with longer maturities and very low interest rates. But its potential can be fulfilled only if it provides them with adequate financing levels and plays its expected catalytic role with the required speed and flexibility.

These changes could be made with limited political capital but could avoid a dangerous destabilisation, a weakening of partnerships between Western countries and the Global South and potentially, much higher costs for G20 countries in the future.